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A contrario

In Defense of Making Things: Why Manufacturing Still Matters

Theodore
Pelagidis and

Michael
Mitsopoulos

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Theodore
PelagidisProfessor of Economics, University of Piraeus, Greece and NR Senior Fellow, Brookings Institution, USA. The author served as an external expert in the Internal Evaluation Office of the IMF, 2015 spring term.

The authors have also published the two following books: (2014) Greece: From Exit to Recovery? Washington (DC), Brookings Institution Press, and (2018) Who’s to Blame for Greece. How Austerity and Populism are Destroying a Country with High Potential, 2nd edition, Basingstoke (UK): Palgrave MacMillan.

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A relatively recent International Monetary Fund (IMF) publication[1] is not the only voice that suggests the possibility of achieving
prosperity and growth in the modern age without the need to have a strong manufacturing
base. Like agriculture before the industrial revolution, “making things” appears to take
the back seat as services, and in particular knowledge intensive services that determine
“how to make things”, take over as growth drivers. Of course, the trends of progress are
irreversible, and “making things” will constitute a shrinking part of employment and,
possible value created. The latter will most likely be even truer if one cannot separate
perfectly the value of incorporated services, as the knowledge content of the “things
made” and the incorporated services build their own complex interactions and grow
exponentially.

However, as we argue here, there will always be a need to make things (including the
occasional spacesuit taking a drive in its interstellar Tesla car). Even as the
relationship between physical manufacturing, knowledge and services becomes more blurred,
manufacturing will remain an indispensable ingredient of the final product. As pointed out
in the literature, the role of manufacturing is and will never be the same for developing
and developed countries, performing different roles in both. For developing countries, it
will still contribute towards the rapid development of key skills that will complete the
skills set of the country[2], and for developed countries,
it will have a mature and symbiotic relationship with services[3], ensuring the proximity of the know-how and the production of goods that
incorporate it, seamless cooperation, and design and service development at the
frontier.

Within such a setting, measuring the importance of manufacturing through its share
in employment or value added may not really capture its contribution to the success of the
business ecosystem of any country.

The classic study of Dertouzos, Solow and Lester[4]
highlighted already decades ago the problem of the thinning production base in the USA,
suggesting that even while an economy moves towards becoming a service economy it should
not neglect its production base. The latter, the authors note, acquires a symbiotic
relationship with services, which are included in the value chains giving rise to
opportunities for the growth of services. Decades later, a new research initiative from
MIT titled Production in the Innovation
Economy[5], reaffirmed these findings,
documenting a relationship that emerges to be very fluid with respect to the attributes
that define the relationship between production and services[6]. Neither, moving production to other countries not the emphasis on services
harm a priori the ability of an economy to
produce and innovate, if a sufficient mass of productive activities that cover a
sufficiently diverse array of activities and skills is maintained. The initiative
reaffirmed that in all developed countries, but also in the developing countries that have
established in the past decades a strong production base, the knowledge and experience
that follows when one “makes things” is ultimately a necessary precondition to maintain
the ability to further develop the services that concentrate around value chains that
include production. In addition, the importance of the production base, not only with
respect to its size but also regarding the dispersion among many activities, skills and
specializations as well as the ability to interconnect these points of economic activity
in a way that encourages the emergence “of the new and unexpected” has been quantified by
researchers at Harvard and MIT[7].

Thus, even while its share of overall economic activity declines[8], as well as its role in the dynamics of output per worker as the
IMF report argues (IMF, 2008: ibid.[9]), manufacturing is likely to maintain a changing, but key, part
of the skills set. Skills sets that enables an economy to produce and offer more complex
goods[10], services and combination of such in a world that,
ultimately, extends the realities documented for manufacturing by the abovementioned
Atlas of Economic Complexity to the blurred, and
less well documented, coexistence of services and goods.

In the age of the knowledge economy, the comparative advantage of any country is not
given but can be built to an extent unseen so far in the history of humanity. The
comparative advantage of Ricardo is not limited any more by geography or climate, but can
be built by any country, at least to the extent that it has the economic and institutional
ability to do so and that the factors of production are now highly mobile. At the same
time, countries that lack this ability, as well as the ability to equip their population
with the skills and knowledge needed, discover that their ability to catch up can be
compromised rapidly, with the growth drivers in the most advanced countries rushing
ahead[11] while shredding low skilled labour[12]. This is a process that has been observed before, during the
age of industrialization, and it appears to have contributed significantly to the
inability of developing countries to nourish their own skill and activity set[13]. It is also a process that according to recent research[14] appears to affect also regions within countries.

In such a setting, and irrespectively of the convergence of productivity among
countries in the manufacturing and services sector, the main challenge for each country is
to build on the existing economic activities to first establish the basics of a balanced
business and knowledge ecosystem, and subsequently to allow it to fulfill its full
potential within in a favorable environment of strong institutions[15].

While the specific attributes of what is at any age defined as a “well balanced
entrepreneurial and economic ecosystem” surely changes across time, it appears reasonable
that its definition relates not only towards having a sufficient diversity of activities,
and thus also diverse skill set. It also includes the need to have a well-balanced
distribution of companies by size. Such a balanced ecosystem contributes towards a
capacity to take better advantage of the externalities that can build up within the
context of the knowledge economy.

The manufacturing sector stands out as sector that tends to seek support from such
diverse ecosystems. The fact that it draws on numerous different needs and skills[16] has a qualitative impact on the way manufacturing companies
depend on, and influence, extended and diverse networks of suppliers and customers, that
increasingly integrate with service providers along more complex value chains that tend to
incorporate a broader skill set. A weakened manufacturing base is therefore linked, most
likely in a two-way causal relationship, with weaker ecosystems around manufacturing
companies. These, in turn often form clusters that educate employees and allow for the
diffusion of good practices and standards. More importantly, they form a customer base
that offers many diverse young companies the opportunity to establish a cooperation that
has enough visibility for them to take the plunge and invest in equipment and skill
development that, under other circumstances, would be too risky for them to try[17].

This position is supported by a great deal of research that seems to confirm that
countries with a stronger manufacturing base can produce more goods that are in demand in
global markets, and that they have a key advantage with respect to the cooperation between
businesses and centers that perform R&D, along a better ability to turn R&D into
sound output[18]. This point in turn also justifies the
addition of the dimension of company size in the definition of the well-balanced
ecosystem, as R&D and innovation is dependent on both the vigour of fast growing young
companies[19] and the ability of large companies to finance
more demanding projects[20].

The documentation of all this, in the numbers picked up in input-output tables, may
indicate a small contribution of manufacturing, but one should not underestimate the
enabling impact that goes beyond the value flows. Taking away a springboard to complex
interactions may undermine the growth potential[21] by more
than is documented in the accounting exercises that allocate value added across sectors,
as electricity production amounts only to a small fraction of GDP but, in the end, is
indispensable to the maintenance of a much larger part of yearly GDP[22].

Thus, there is more to the relationship between prosperity and manufacturing, than
the fact that gradually services become more important in a knowledge-based economy that
races towards the digital age, as the IMF report states. Manufacturing may not be any more
the symbol of economic superiority, but it does emerge as a key enabler and facilitator,
with a role that changes in its nature and contribution in employment and value added
without necessarily ceasing to be necessary and useful. This changing role highlights in
turn, once again, how important it is for a country that wants to ensure prosperity for
its people, beyond short growth spurts[23], to ensure that
the regulatory and tax framework does not erect unneeded hurdles that hold back successful
companies and their employees from progressing, nor to the constant transformation of
companies and supply changes as new solutions that increase efficiency become available
and the pressures of competitive markets push to making the most of them. Only in such a
setting companies that have acquired a competitive advantage can grow on the merit of
hiring employees and introducing productivity enhancing innovation in the production
process and creating in the end the preconditions needed for an increase in prosperity. It
appears, given the extensive literature at hand, to be no coincidence that the countries
that appear to have all these attributes simultaneously are also institutionally mature
counties, that generally have a well working social state that ensures a retributiveness in the case of high-tax countries, and that
have mostly deregulated network industries ensuring that they offer competitive services
to the users that are part of the productive ecosystem in the country. These are also
generally countries that manage to have overall a higher employment ratio and in which a
favorable business and institutional environment, among others, also allows the more
complex and in need of long-term visibility, and therefore dependent on good institutions,
manufacturing to flourish.

Suzanne Berger, with the MIT Task Force on Production in the Innovation Economy
(2013) Making in America. From Innovation to
Market, MIT Press, and Richard M. Locke and Rachel Wellhausen, eds (2014)
Production in the Innovation Economy. Cambridge:
MIT Press.

The IMF report regarding the declining share of manufacturing jobs declare that:
“This concern stems from the widely held belief that manufacturing plays a unique role as
a catalyst for productivity growth and income convergence and a source of well-paid jobs
for less-skilled workers” And it continues by arguing that: “Against that backdrop, this
chapter aims to provide new evidence on the role of manufacturing …that a shift in
employment from manufacturing to services need not hinder economy-wide productivity growth
and the prospects for developing economies”. See https://www.imf.org/en/Publications/WEO/Issues/2018/03/20/world-economic-outlook-april-2018#Chapter%203

Assolombarda Confindustria, Milano Monza and Brianza (2016) The Performance of European Firms: A Benchmark Analysis A Survey on
650 European Companies in the Five most Dynamic Regions of Europe. RICERCA
No4.